PAYE vs. IBR: Which Income-Driven Plan Is Better for Your Wallet?

 January 23, 2020
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If you’re struggling to make your student loan payments, you may need to switch to an income-driven repayment (IDR) plan. As the name suggests, IDR plans adjust your student loan payments based on your income, making them easier on your budget.

As you’re choosing between income-driven repayment plans, you may find yourself torn between Pay As You Earn (PAYE) versus Income-Based Repayment (IBR). Let’s take a closer look at these two popular plans to discover which one may work best for you.

PAYE vs. IBR – At a glance
PAYE vs. IBR – How are they different?
PAYE vs. IBR – Which should you choose?

PAYE vs. IBR At a glance

Both plans have a lot in common, as they both are based on your income, but they also have some key differences. Here’s a look at how Pay As You Earn versus Income-Based Repayment compare:

Payment Amount 10% of discretionary income 10% of discretionary income if borrowed on or after 7/1/2014
15% of discretionary income if borrowed before 7/1/2014
Payment Term 20 years 20 years if borrowed on or after 7/1/2014
25 years if borrowed before 7/1/2014
Borrower Requirements Payments on 10-year standard plan must exceed 10% of discretionary income;
Must be a new borrower as of 10/1/2007;
Must have borrowed a direct loan on or after 10/1/2011
Payments on 10-year standard plan must exceed 10% or 15% of discretionary income
Loan Forgiveness Yes, after 20 years (Forgiven amount may be taxable income) Yes, after 20 or 25 years
(Forgiven amount may be taxable income)
Direct Loan Consolidation Required Sometimes Less frequently

PAYE covers most federal loans but excludes private student loans and certain loans made to parents, such as direct PLUS and FFEL PLUS Loans. However, PAYE requires you to take out a direct consolidation loan before you can qualify to switch to the plan.

To get on IBR, you need to show that you have a high debt-to-income ratio. You’ll typically qualify for this plan if your federal student loan debt exceeds your annual discretionary income or represents a large percentage of your overall annual income.

Like with PAYE, most federal loans are eligible for IBR. Loans that don’t qualify are certain loans made to parents and private student loans.

PAYE vs. IBR: How do they compare?

1. PAYE may lower your student loan bills more than IBR

If you have student loans from before July 1, 2014, PAYE may give your budget more breathing room compared with IBR. That’s because PAYE caps your student loan bill at 10% of your income. However, under IBR, payments for your older loans are set at 15% of your income. If you took out your loans on or after July 1, 2014, though, your payments will be capped at 10% of your income, just like on PAYE.

2. PAYE offers loan forgiveness up to 5 years earlier than IBR

As shown, both plans offer student loan forgiveness if you still have a balance at the end of your repayment term. However, if you qualify for PAYE, you may be able to get out of debt five years earlier than under the IBR plan. That’s because all PAYE borrowers qualify for forgiveness after 20 years of payments, but IBR borrowers with student debt predating July 2014 will be on the hook for 25 years.

Remember, though, a forgiven loan may be treated as taxable income. So, if you have a bigger balance after 20 years than you would after 25, you could get hit with a bigger tax bill.

3. Both plans have interest benefits, but PAYE has a better one

One nice perk of both IBR and PAYE is their interest benefit for subsidized loans. If the interest that accrues on your subsidized loans each month is greater than your payments under PAYE or IBR, the government will pay the difference. This benefit lasts for up to three years from the day you begin repaying under PAYE or IBR.

One key difference between these two repayment plans comes down to the amount of interest that may be capitalized. Under PAYE, if you no longer qualify to make income-driven payments, the unpaid interest that may be capitalized is limited to 10% of the loan balance you had when you entered the PAYE Plan. On the other hand, IBR does not limit the amount of interest that may be capitalized.

4. PAYE is harder to qualify for than IBR

While PAYE may further reduce your student loan bills and get you out of debt faster than IBR, it can be harder to qualify for.

To get on the PAYE Plan, you need to be a new borrower as of Oct. 1, 2007, and your direct loans must have been disbursed on or after Oct. 1, 2011. IBR has no “new borrower” qualification requirement.

5. IBR doesn’t require you to consolidate most loans

For some student loan borrowers, IBR may be easier to apply for than PAYE for more than just the reason cited above. That’s because unless consolidated, the following loans do not qualify for PAYE:

  • Subsidized Federal Stafford Loans from the FFEL Program
  • Unsubsidized Federal Stafford Loans from the FFEL Program
  • FFEL PLUS loans made to graduate or professional students
  • FFEL Consolidation Loans that didn’t repay PLUS Loans made to parents

The above loans qualify for IBR without consolidation. To apply for PAYE with these loans, you’d first need to get a direct consolidation loan.

That said, both plans ask you to consolidate Federal Perkins Loans. Note that although the Perkins Loan program expired in September, 2017, they are still eligible for PAYE or IBR as long as you consolidate them first.

PAYE vs. IBR – Which should you choose?

In some respects, Pay As You Earn Plan comes out as the clear winner against IBR. It lowers your monthly payments to just 10% of your discretionary income and offers loan forgiveness after 20 years, no matter when you borrowed your loans.

But, as discussed, qualifying for PAYE can be a hurdle for some borrowers. IBR, meanwhile, is easier to qualify for, and you may not need to consolidate any loans before applying.

Whether you opt for PAYE or IBR, you’ll have to recertify your eligibility year after year. If your income goes up, your payments will rise, too. The silver lining is that your payments will never go higher than if you were on the Standard Repayment Plan.

To see how you’d fare under PAYE, play around with our PAYE Calculator. And, to estimate what your payment could be under IBR, check out our IBR Calculator.

Refinancing may also help lower your monthly payments

PAYE and IBR are not your only options for managing student loans. If you don’t meet the requirements for these repayment plans, you may be able to lower your monthly payments with student loan refinancing.

Student loan refinancing can be a good strategy for borrowers with a steady income and good credit score. When you refinance, you consolidate your student loans with a private lender. Depending on your credit history, you could also qualify for a lower interest rate and better terms. And if you’re looking to lower your monthly bills, you could choose a longer repayment term.

Keep in mind that if you extend your repayment plan, you may end up paying more interest over time. Luckily, once you start earning more money, you can pay more on your loan to get out of debt faster.

In addition, when you refinance your loans with a private lender, you will lose out on certain federal protections like loan forgiveness, income-driven repayment plans, and deferment and forbearance options. As you think through your student loan repayment strategy, be sure to weigh the pros and cons of each approach carefully.

If you’re struggling to keep up with bills, getting on an income-driven repayment plan or refinancing your loans could be the solution you need. If PAYE or IBR sound like the right plan for you, learn how to apply for an income-driven repayment plan.

Laura Gariepy contributed to this report.